10th June 2014
Darius McDermott, Managing Director
Just under two years ago, Mario Draghi, President of the European Central Bank (ECB), promised he'd do whatever it would take to save the Euro. His words alone seemed to be enough for markets and until now, he has not been tested. Last week, however, he started to make good on his promise.
Faced with continued falling inflation (and the very real possibility of deflation), high unemployment and slow growth, he finally put his money where his mouth is - or he almost did. He didn't quite go as far as printing money and buying government bonds like his counterparts in the UK, US and Japan, but he did announce a series of measures, designed to combat deflation, depreciate a very strong Euro, and keep Europe on the path to recovery.
Included in the measures was a €400 billion injection of cash, very similar to the Funding for Lending scheme adopted in the UK. The main European interest rate was cut from 0.25% to 0.15%, and there was also the introduction of negative interest rates on bank deposits. This was basically a move to put a levy on banks, charging them to hold cash reserves. It is hoped that these measures will result in banks starting to lend again, rather than just boosting their own balance sheets.
As the good people at Allianz pointed out, by implementing the above, and hinting at the possibility of quantitative easing, the ECB has managed to deliver some much needed stimulus but crucially still kept much of its powder dry. Interest rates can't really go much lower, but the other measures could still be increased if necessary.
And it may be that more stimulus is needed. Denmark had negative interest rates for two years and, while it helped depreciate their currency, their experience showed us that it doesn't necessarily lead to banks lending. If there is no demand, it won't make any difference.
Overall, however, the ECB's latest package should be supportive for risky assets - both equities and, in particular, bonds from the EMU periphery.
Personally, I'm quite optimistic about European equities, even periphery markets, which have already seen quite a significant bounce. Yes, the easy money has been made, but Europe is home to a large number of world class companies, many of which got hammered, due to where they were listed rather than what their prospects were. These companies are currently trading at a discount to their global peers. Indeed, Europe is still the cheapest of all developed markets, bar Japan.
A word of caution, however. As in other developed markets now, earnings are going to be key to continued market rises: if earnings can come through, markets should continue to do well. If earnings don't come through, markets could struggle.
When it comes to periphery bonds, I'm far more wary. For example, back in 2012, Greece's bonds yielded nearly 50%. After the biggest debt restructuring in history, they recently sold €3 billion of five-year bonds to the market, yielding less than 5%. That is surely not enough. As one economist pointed out, if you are buying Greek five-year bonds, it is because you think they will default in six!
Bryan Jones, head of fixed income at Rathbones, is also cautious saying: "High yields have hit a new low, and peripheral debt is stronger. We have concerns about both asset classes, which have now been turbo charged."
So Mario Draghi has showed he is indeed willing to use his super powers, but the story is far from over.
Elite Rated European equity funds:
Baring Europe Select
BlackRock Continental European
BlackRock Continental European Income
BlackRock European Dynamic
Henderson European Focus
Henderson European Selected Opportunities
Jupiter European Special Situations
Threadneedle European Select
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius' views are his own and do not constitute financial advice.